Pension backed funding: Could it help fund the growth your business?
Author David Hugo Hargreaves the Chief Guru at The Growth Gurus.
Alongside banks, crowd-funding, peer lending and equity finance — business owners could consider tapping in to their pension pot as an excellent funding option.
Should you consider pension backed funding to finance your growing business?
£200Billion of pension funds belongs to small to medium sized business owners.
For the last 10 years business owners have been able to deploy some of their pension funds into their business to support its growth and help realise its potential.
Pension backed funding just has to be done carefully and with respect for the letter and spirit of the rules surrounding the transaction.
Investing pension funds into your own company
A business owner needs funding and has accumulated pensions from present or previous employment.
All or some of these pensions are transferred into a small self-administered scheme (SSAS).
A SSAS is a form of executive pension trust that allows the owner, not an insurance company or IFA, to make decisions as to where their money is invested.
In the case of pension backed funding from The Growth Gurus, a review of the business is then undertaken.
Essentially we test the viability of the business to make sure, as far as reasonably possible, that any investment by the pension in your enterprise will be repaid and generate a profit for the pension scheme.
It is, after all, your pension and you will want to spend the proceeds some day!
Assuming that the case for investment is sound, the loan to your company normally takes one of two shapes.
Your SSAS may purchase an asset such as an office from the clients company, the client’s personal name or as a third party purchase.
The SSAS can also buy a commercial property alongside the business owners.
The SSAS can also have a mortgage towards purchasing the asset.
The property can even be leased back to the company as either the sole tenant or as one of many tenants.
Using SSAS funds to buy a property is a really cool way to get on the commercial property ladder
How much does pension backed funding cost?
Like most other funding products the answer to the question about cost is ‘it depends’. Cost is influenced by deal size, complexity and the levels of advice needed to secure a compliant outcome.
It is important to remember that with pension backed funding interest costs do not get paid to a third party, they go back to the business owners own pension scheme, and thus in most cases, the real cost is likely to be less than a more traditional loan style arrangement.
For instance, an AccountingWEB Alternative Funding Guide published in 2016 compared the cost of different business funding solutions to a small business when borrowing £75,000 over a five year term. It concluded that pension backed funding was more competitive than peer 2 peer funding, a bank overdraft, invoice discounting and factoring. Compared to a bank overdraft, pension backed funding was almost half of the cost — £11,296 over five years compared with £20,625 for the bank overdraft.
What are the benefits?
There are several key benefits, the most obvious being that the interest costs associated with funding your own business serving to build your own pension, something that is just not possible with most other forms of business funding.
Buying a property with your SSAS has substantial tax benefits, not least, no tax on the rental income and the asset falls outside your estate for inheritance tax.
Also, if you or your pension are forced into insolvency then the SSAS owns the property and the property is not included in the insolvency.
Equally the ability of pension backed funding to collaborate with other lenders as part of a funding package is often a real advantage.
Pension backed funding frequently plays a lead role in facilitating a larger overall funding solution as lenders are normally keen for a business owner to show willingness to back themselves.
The ability to leverage the value of the business’s Intellectual Property (IP) is also a prominent benefit. Existing lenders may already have a charge over the debtor book, machinery or other assets but virtually all are happy for The Growth Gurus to fund against the IP — the ideas, relationships, brands or processes that characterise the business. This often means that a greater overall level of funding is achievable.
There are numerous other benefits however as each funded deal is uniquely tailored to the circumstances of the business and its owners an examination of the all of the possible parts would be too exhaustive for this piece.
What are the risks?
All business carries risk, especially businesses that have sourced finance from a third party. With pension backed funding the initial risk is clear. If you invest some of your pension money into your business and the business subsequently fails, you may lose some or all of your investment. This is why the screening and testing process for a pension backed funding deal is rigorous and robust.
In reality virtually no business fails immediately after securing a pension backed funding deal. More likely a serious issue will occur a few years into the life of the deal so the individuals risk is mitigated by the length of time since the deal occurred and the number of repayments that have been received by the pension. Risk is therefore apparent on a declining scale back to zero when, typically, five years after the original funding took place, the pension has received back all of its original investment plus its profit.
It must be emphasised, however, that a sensible candidate for a pension backed funding deal would have both a high degree of confidence in their own enterprise and also a broad balance of personal assets to fall back on in the event of a business failure.
Increasing your company profits.
With pension backed funding, a theoretical virtuous circle has thus been created since a well-funded business should be capable of generating greater profits, which, in turn can be used to fund more generous pension contributions for the business owner.
We’ve covered the risks and it’s not a decision to take lightly but whether the whole thing is a good idea is usually the starting point of any pension-led funding discussion.
This article was written by David Hargreaves the chief growth guru and principle ‘dreamer’ at The Growth Gurus
About David Hargreaves
David is a seasoned and accomplished entrepreneur who’s first business was started from home and grew to a turnover of £12m before David’s Exit.
David is passionate at helping business founders to be the best they can be, to make pots of cash by serving their customers and to have a happy family life.
About The Growth Gurus
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Author David Hugo Hargreaves the Growth Guru at The Growth Gurus.